13 January 2023 • 10 min read
Farming, staking, mining—it might sound like the worlds of farming and geology, but we’re actually referring to crypto.
Despite the varying degrees of complexity involved in cryptocurrency and DeFi (or decentralized finance), many people have learned to leverage their stakes so that they generate as much income as possible. Yield farming, staking, and liquidity mining are three passive income strategies to make your crypto work for you rather than just having it sit in your wallet.
In this comprehensive guide, we’ll begin with a brief introduction to DeFi before covering these three strategies along with the risks and rewards associated with each of them. By the end of the article, you’ll be able to make an informed decision about which method for earning passive income in crypto is right for you, whether you’re trying to increase your crypto stakes, diversify your portfolio, or prioritize liquidity.
Yield farming is the process of using decentralized finance (DeFi) to maximize returns. But let’s back up for a moment to cover an important question: What exactly is DeFi and how can you use it to maximize your income?
DeFi is an emerging financial technology that’s based on secure distributed ledgers similar to those used by cryptocurrencies. At the other end of the spectrum is the centralized financial system, which—at least in the United States—is regulated by the Federal Reserve and the Securities and Exchange Commision (SEC), which defines the rules for legacy financial institutions such as banks and brokerages.
DeFi challenges the centralized financial system by empowering individuals with peer-to-peer digital exchanges. In many ways, DeFi has made banks and the fees charged by these centralized, legacy institutions irrelevant. Now anyone with an internet connection can harness the emancipatory power of decentralized finance. Whether you want to hold money in a secure wallet or make transfers, you no longer need to rely on third-party institutions to manage your finances.
So what does all of this have to do with yield farming? When users engage in yield farming, they’re lending or borrowing crypto on a DeFi platform and earning cryptocurrency in exchange for their services. The process typically involves lending crypto assets to DeFi platforms, which lock up those assets in a liquidity pool, with the lenders earning interest on their lent assets (otherwise, why would someone lend and lock them up for a period of time?).
The lent funds in the liquidity pool provide liquidity to a DeFi protocol and are used to facilitate trading, lending, and borrowing. As part of providing liquidity, the DeFi platform then earns fees, which are paid out to investors based on their share of the liquidity pool. In other words, the more capital that you provide to the liquidity pool, the higher your rewards.
A simple explanation for staking is that it’s a way of earning rewards for holding certain cryptocurrencies. However, It’s important to note that only some cryptos allow staking (currently those options include Ethereum, Tezos, Cosmos, Solana, and Cardano). If the coin you hold does allow it, you can “stake” a portion of your holding in order to earn a reward over time.
So why does your crypto earn rewards while it’s staked? The short answer is that the blockchain puts it to work. Cryptos (and here Ethereum’s recent Merge is a great example) that allow staking use a consensus mechanism known as “Proof of Stake” (PoS), which ensures that all transactions in their blockchain are verified and secure even though there’s no bank or payment processor involved.
When you stake some of your crypto, it becomes part of the validation process on the blockchain. Long-term crypto holders often see staking as a way of making their assets work for them by generating rewards, since their coins would otherwise be sitting idly in their crypto wallets. After all, why HODL when you earn?
Additionally, staking contributes to the overall robustness of a chain by adding to its security and efficiency. When you stake some of your funds, you’re helping make the blockchain more resistant to attacks as well as strengthening its ability to process transactions in a quick and cost-effective manner.
Yield farming and staking are both ways to earn passive income using your crypto holdings. They both require a user to hold some amount of crypto assets in order to generate profit. But while the two terms are sometimes used interchangeably, they’re notably different.
Yield farming is generally considered more complex than staking. With staking, investors simply need to decide on the staking pool and then lock in their crypto. Yield farming, on the other hand, can require a bit more active management in order to maximize profits, as investors have to pair their tokens with a platform, with many switching tokens and platforms frequently.
Many consider yield farming to offer a better yield than staking, but more risk-averse investors still prefer the latter. One of the reasons is because yield farming is often practiced on newer DeFi projects, meaning there’s a stronger risk of a “rug pull.” Staking, on the other hand, is more common on established PoS networks, where this risk is diminished.
In both yield farming and staking, there is nevertheless a level of risk associated with volatility. Both yield farmers and stakers may lose money if tokens suddenly drop in value. There’s also the risk of liquidation, which can occur when your collateral is no longer enough to cover your investment.
When it comes to profitability, yield farming and staking also see quite different returns (commonly measured in “annual percentage yield,” or APY). Staking tends to have steadier APY returns when compared with yield farming, and staking rewards typically fall into the range of 5% to 14%.
While such numbers may seem like worthwhile returns, yield farmers can reap even more sizable profits, with returns ranging from 1% to 1,000% APY. As mentioned, though, greater rewards necessarily mean greater risks with yield farming, and an ill-advised investment can have a lasting negative impact on your portfolio.
Whether yield farming or staking is the better option really depends on your perspective and your priorities as an investor, and whether or not those priorities are oriented around short- or long-term investing.
For investors who are looking for a shorter time horizon, staking can be an attractive option because it allows investors to generate rewards immediately during transaction validation. For example, staking can be used to mine a PoS coin like Cardano (ADA), and staking ADA does not offer any additional risk beyond those associated with owning Cardano. With an active yield farming strategy, the expected return may be higher, but the risk is higher as well. Plus, if you’re looking for liquidity, yield farming doesn’t require locking up your funds. You’re able to attempt to generate returns on platforms that offer a high APY.
For long-term investments, yield farming has the potential to be fairly lucrative over time. Since nothing is locked in place for a certain period of time, you can move between platforms and tokens as you attempt to find the best yield, making yield farming a great way to diversify your portfolio. However, you will need to pay attention to gas fees in order to ensure that they are not offsetting your profitable returns.
Whether you decide on staking or yield farming will also likely depend on how actively you want to manage your investments. Staking may be less profitable, but the associated risks are also fewer. Ultimately, staking is more stable, but yield farming has the potential to be more profitable.
With the ongoing crypto winter and speculations about when the next crypto bull run will occur, many investors are wondering if yield farming is still a profitable strategy. The simple fact is that, as crypto and DeFi grow in popularity, it has become more and more difficult to make significant profits within a relatively brief period of time, unless, of course, you decide to engage in margin trading, which carries its own sets of risks and rewards.
Even in 2023, some yield farms can offer APYs of up to 3,000%, with APYs of over 100% remaining easy to find. (When compared with a savings account at a standard centralized bank, which offers an average APY of just 0.22%, yield farming is an incredibly attractive option.)
Although the total value locked (TVL) in yield farming protocol’s isn’t as high as it was during the “DeFi summer” of 2020, it remains above $6 billion, a clear indication that yield farming is still an avenue for profit generation in 2023—even during the current crypto bear market.
Nevertheless, it is important to remember that, despite the potential for an extremely high ROI, yield farmers need to be vigilant about the possible risks involved.
Liquidity mining is a type of yield farming—another DeFi lending protocol in which users stake their cryptocurrency into a pool where it can be used by others. Liquidity mining yields coins from the platform on which users are lending, which is why it’s crucial for investors to pick a platform with coins that they believe will increase in value.
As with any liquidity pool, lenders are rewarded proportionally to the amount of the liquidity pool for which they provided. Liquidity mining may sound quite similar to staking, but there are important differences related to the types of rewards that investors can expect to achieve.
Staking is considered to be the safest of the three above-mentioned passive income strategies. Over $100 billion in crypto assets are currently being staked, and they’re the backbone of many larger and more established cryptocurrencies. Yield farming and liquidity mining, on the other hand, generally operate on more niche or less frequently used platforms.
Liquidity mining is directly related to keeping blockchain technology decentralized, but the main difference between it and staking can be understood in terms of the rewards received. Liquidity miners generally receive the native token of the blockchain, meaning they have the chance to earn governance tokens, giving them a vote on any new legislature (thereby empowering miners).
Whether staking or liquidity mining is the better of the two options remains a hot topic of debate. Staking is generally considered safer because it usually takes place on more established exchanges. Both yield farming and liquidity mining involve DeFi.
When liquidity mining, you must interact with a decentralized exchange or “DEX,” making it imperative to do your own research before getting involved. While rewards can be high, the stakes (and potential pitfalls) are high, too. Some of the most trusted DeFi platforms include Pancake Swap, Sushi Swap, 1inch, Uniswap, and Curve Finance. In terms of your possible liquidity mining journey, these five options would be excellent places to begin.
It’s also important to note that the rewards for liquidity mining generally come in the form of the exchange’s native tokens, meaning that you’ll want to think carefully about which tokens you anticipate increasing in value over time. If the tokens decrease in value, your rewards will essentially be negated.
Since it often allows crypto investors to earn steady streams of passive income, liquidity mining is one of the most common forms of yield farming. But there are several important benefits when it comes to liquidity mining that may motivate investors to take the plunge, including a passive income stream and the distribution of governance tokens (although large investors can still usurp governance roles).
It also presents a low barrier to entry. You don’t need to have an outsized crypto stake in order to join. In addition, all parties within a DeFi marketplace benefit from liquidity mining: lenders are rewarded for lending their tokens; traders using the DEX benefit from an efficient and liquid marketplace; and the marketplace itself benefits by fostering a community based on trust and a diverse pool of users.
Generally speaking, staking is considered one of the safest ways to earn passive income with your crypto. It has a very “technical” purpose insofar that it supports the blockchain itself and is used to validate transactions on networks that use a Proof-of-Stake consensus mechanism.
There are, however, plenty of other passive income strategies when it comes to crypto, including interest-bearing digital asset accounts, lending (including margin lending, peer-to-peer lending, and others), cloud mining, dividend-earning tokens, and crypto copy trading.
In fact, Trality’s Marketplace offers a simple, safe, and secure way for investors to profit from both automated algorithmic trading and copy trading—all in a transparent manner with full historical metrics for easy evaluation.
Instead of having to rely on unproven crypto trading bots created by anonymous bot creators, Trality’s Marketplace offers a bespoke space with fully-vetted, hand-picked bots from the best bot creators, making it possible to earn consistent passive income returns while minimizing risk. Moreover, the Marketplace requires minimal input: simply select a bot based on your risk tolerances and rent it.
Yield farming, staking, and liquidity mining are three of the most popular methods for earning passive income on crypto holdings. While they have varying degrees of profitability, safety, and popularity, they’re all good ways to make your crypto work for you. They’re also a great alternative to letting your crypto gather dust while sitting in your digital wallet (which should be a non-custodial cold wallet!).
But it’s equally important to note that there are safer, more profitable alternatives to yield farming, staking, and liquidity mining, chief among them being a bespoke space such as Trality’s Marketplace.
As with all crypto trading, though, it’s crucial that you understand the risks involved with each investment approach before deciding on a specific one (or combination or approaches). Nascent DeFi exchanges can be volatile environments, and so the golden rules of investing still apply: never invest more than you can afford to lose and always do your own research.